Hello, and welcome to Q2 2018 Harvard Bioscience, Inc. Earnings Conference Call. My name is Michelle. I will be your operator for today's call. (Operator Instructions) Please note, this conference is being recorded. I will now turn the call over to Corey Manchester. Corey Manchester, you may begin.

Thanks, Michelle, and good afternoon, everyone. Thank you for joining us for the Harvard Bioscience Second Quarter 2018 Earnings Conference Call. Leading the call today will be Jeffrey Duchemin, President and Chief Executive Officer; and Robert Gagnon, Chief Financial Officer of Harvard Bioscience. Before I turn the call over to Jeff, I will read our safe harbor statement.

In our discussion today, we may make statements that constitute forward-looking statements. Our actual results and performance may differ materially from what we have projected due to risks and uncertainties, including those detailed in our annual report on Form 10-K for the period ended December 31, 2017, and our other public filings. Any forward-looking statements, including those related to the company's future results and activities, represent our estimates as of today and should not be relied upon as representing our estimates as of any subsequent day. Also, much of today's call will focus on our non-GAAP quarterly results, which we believe better represents the ongoing economics of the business, reflects how we set and measure our incentive compensation plans and how we manage our business internally. The differences between our GAAP and non-GAAP results are outlined in the earnings release we issued today, which can be found on our website under press releases. Additionally, any material, financial or other statistical information presented on the call, which is not included in our press release, will be archived and available in the Investor Relations section of our website. A replay of this call will also be available for 1 week at the same location on our website at harvardbioscience.com. I will now turn the call over to Jeff Duchemin. Jeff, please go ahead.

Thanks, Corey. Good afternoon, everyone, and thank you for joining us for our Q2 earnings call. We had a great quarter, and I'm excited to share a number of highlights with you today. Our CFO, Rob Gagnon, will provide further detail on our second quarter financial results. And after that, we look forward to taking your questions.

During the second quarter, we produced excellent business results in revenue and earnings. Second quarter revenue was $31.6 million, reflecting a 25% increase over revenue for the second quarter in 2017. DSI contributed approximately $10.6 million to our second quarter revenue, while currency translation was a $600,000 favorable tailwind. Finally, our legacy product families, PCMI and electrophysiology, when combined, grew 8% in the quarter. This was a record quarter in terms of reported revenue for Harvard Bioscience. I'm extremely proud of the execution of our global team and feel very confident based on our strong first half of the year that we are well on our way to achieving our financial goals for 2018.

Taking a look at revenue from geographic standpoint. Revenue in Europe grew for the third consecutive quarter. Our revenue in Europe for our legacy business, excluding DSI, grew approximately 24% year-over-year. Our commercial teams have done an excellent job turning around the business. The initiatives we put in place last year have provided a catalyst for growth in the European region. With the acquisition of DSI, we are confident in our positioning in the European markets and our growth prospects moving forward.

Our revenue in China for our legacy business, excluding DSI, was up approximately 11% in the quarter. We are well positioned to continue to outperform the overall market, and adding DSI to our portfolio should only increase our competitive advantage in this growing market. Although there has been uncertainty in China around the impact of potential tariffs, we have not experienced any setbacks or slowdowns to date. We are continuing to monitor the situation, but as for now, feel the broader life science tool industry in China will continue to be a growth driver for our business. Our ongoing legacy U.S. business, excluding DSI, declined approximately 2% in the second quarter. This was the result of the timing of some large system sales in our electrophysiology product family, which took place in the second quarter of last year in the U.S. We are excited, however, to report that excluding electrophysiology, which represents approximately 30% of our U.S. business, the remaining product lines in the U.S. grew over 3%. The growth of the remaining 70% reflects the health and positioning of our business in the U.S.

In addition to our top line growth, our margins and earnings improved substantially this quarter. Rob will get into the quarterly detail shortly, but we are very pleased with the performance of the business. We are well on our way to meeting and hopefully exceeding our expectations for financial performance in 2018. Before turning the call over to Rob, I'd like to give an update on DSI and business integration efforts. We are at the 6 month mark of the acquisition, and I'm more excited than ever with the business. Since January, I've spent quite a bit of time at the DSI facility in Minnesota, and as I get to know the employees better, my overall enthusiasm and confidence continues to increase at the prospect of future growth in the business. We have a talented team and an exciting pipeline of products. Sitting here today, we are on pace to realize between $2.5 million and $3.5 million in combined top line and bottom line synergies in the first year.

As I mentioned on the call last quarter, we expect the majority of these synergies to come from cost savings. However, over time, the top line synergies are what will drive long-term shareholder value. To that end, our sales organization participated in a joint sales meeting at DSI earlier this month. It was great to get everyone together to launch coordinated marketing materials and programs that will allow the 2 organizations to cross sell and drive additional growth.

With that, I will turn the discussion over to Rob Gagnon, who will provide more insight into our financials. Rob?

Okay. Thanks, Jeff. As a reminder, most of my discussion will focus on the non-GAAP results. So let's start with the top line. Revenue for the second quarter was $31.6 million, a 25% increase year-over-year. And for comparison purposes, Denville revenue was $6.3 million in the second quarter of 2017 and DSI revenue was $10.6 million for the second quarter of 2018. There is also some foreign currency favorability, which amounted to $560,000 in the quarter. However, Q2 was a great quarter on the top line for us. $31.6 million is a record quarter in revenue for Harvard Bioscience, and organic revenue increased 8%, and we finished above the higher revised estimate range provided last quarter of $30.5 million to $31.5 million. So good result on the top line.

I'll now turn to gross margins. Starting with cost of revenues, were $13.9 million this quarter compared to $13.8 million in Q2 of last year. As a result, gross profit was $17.7 million, an increase of $6.3 million when compared to $11.4 million in the second quarter of 2017. That resulted in impressive gross margins of 56%, which is over 100 -- or over 1,000 basis point improvement, compared to 45% in Q2 of last year. Per our guidance earlier in the year, we communicated that we expect to see gross margins in the range of 54% to 57%. Q2 result of 56% is well within that range and a real nice improvement and good outcome for Q2. We continue to expect to see gross margins to fall in this range.

I'll now discuss operating margins. Operating income in Q2 was $4.3 million, an increase of $2.6 million compared to $1.7 million from Q2 of last year. As a result, operating margin in Q2 was an impressive 14%. This compares to an operating margin in Q2 last year of 7%. This was one of the major highlights in our financial performance this quarter. In terms of earlier expectations, we had communicated a range of 10% to 13%. Our results this quarter of 14%, an outstanding improvement and ahead of our expectations. We are excited about how the business is performing and pleased with this result for Q2, and we still expect operating margins to be 10% to 13% for the year.

I'll now turn to EPS. Our net income for Q2 was $2.3 million or $0.07 per diluted share, which compares to $870,000 or $0.03 per diluted share for Q2 last year. Again, this was at the high end of our expectation range, which was $0.05 to $0.07. So a good outcome with EPS as well.

Just some housekeeping items. Our tax rate, we came in at 21.5%. That's down from 29.6% in Q2 of last year, and the decrease is due to tax reform. In terms of shares outstanding, our diluted weighted average shares were 36.1 million in Q2 as compared to 34.7 million in Q2 of last year.

I'll now turn to debt for a moment. We closed Q2 at $63 million. When we closed the acquisition back in January, total debt was $69 million. At the time, this represented 4.4x leverage. We continue to pay down debt by leveraging our cash flow. The debt has decreased $6 million, and our leverage now stands at approximately 4x. We are making good progress with servicing the debt, and let me be clear, we have no intention of utilizing the shelf registration statement to service the debt.

Just to recap, today we are reporting strong Q2 financial results. Revenue grew 25% overall. Organic revenue grew 8%. Gross margins were 56%, at the higher end of our expected range. Operating margins 14%, above our expected range. EPS at $0.07, at the high end of our range, and debt declined down to 4x total leverage.

Now to our financial outlook. As a reminder, our practice is to provide annual guidance in our earnings release. At the time of the acquisition, we expected revenue of between $118 million and $123 million. Last quarter, we increased the lower end of that range and revised annual guidance to between $120 million and $123 million. And as of today, we still expect to report annual revenue within that range. For EPS, we still expect to report $0.20 to $0.23. Also note, our financial guidance reflects 11 months for DSI, as the transaction closed on January 31, 2018. Our guidance reflects an impressive 18% to 21% growth in the top line and between 67% and 92% growth in the bottom line. It is important to consider the following when assessing our business for the next 2 quarters: there is seasonality in our business. The third quarter is always the lowest quarter of the year and the fourth quarter is the highest. This result is due to the buying patterns by some of our customers, which we attribute to normal budget cycles and the slow summer months. In terms of how the quarters will roll out, we expect revenue of between $28.5 million and $29.8 million for Q3 and $32 million to $33.5 million for Q4. For EPS, we expect approximately $0.04 for Q3 and in the range of $0.07 to $0.09 for Q4. We will now open the call to questions from participants. Operator?

That's a great growth number, and I'd like to dig into it a little bit. And specifically on the legacy business, the U.S., you said, was light. Do you expect those orders to resume? That's point one, could you talk to legacy? And then what is the growth rate of DSI right now? And then could you put color around these growth rates? Is it NIH, biotech? Could you just kind of start from the top on that.

Yes, Paul, it's Jeff. I'll start with the U.S. business. I'll let Rob discuss DSI. But in regards to the U.S., as you know, our orders are sometimes -- well, actually the billing cycle is a little lumpy. The order activity has been very strong, as you can see in our total organic growth for the business. With the electrophysiology business in the U.S., we had a high comp in Q2 of last year that we're going up against. And the activity is there, the orders are there, it's just a timing of when these orders ship. So we feel confident in the back half of the year that we're going to be right in line with our internal forecast, external forecast around both the electrophysiology business and the PCMI business here in the U.S. The activity in Europe continues to be very, very strong. We continue to see above our expectations in terms of our growth in China. So overall, the legacy business is doing very well on a global standpoint. Rob, with DSI?

Yes. And just to reiterate, the legacy growth rate was -- we've said it a couple times, but was 8% for Harvard Bioscience. On the DSI side, so DSI came in at $10.6 million. Keep in mind, private company, it's in terms of the rigor of closing the books. I think what's important is that we've now owned this business for 5 months. It's performed in line with our expectations and embedded within our overall expectation numbers. We're still on track for the year. So it's on track with what we had expected and where we thought it would be.

Yes. The one other comment, Paul, the NIH you had mentioned, we continue to see positive outlays on an annual basis from the NIH. The academic market here in the U.S. and globally is performing very well right now. And we expect that to continue through the rest of the year.

Well, I mean, Paul, it's sitting here today. We're very confident in the business. We're very confident in the strategy of the business. We've executed to our plan in the first half of the year. We believe we'll execute to our plan in the second half of the year. As Rob said, our guidance is not changing. We still feel very confident that we'll fall within the range of revenue and EPS, and I think that's where we stand today.

Okay. And then last, I guess, I'll dig into a little bit on the operating margin. You did a lot of heavy lifting into legacy business over the past 3 years. You had operating margins roughly, like Rob said, 14% versus 7%. If I look at this 7 percentage point increase in operating margin, what portion was it from your reorg efforts and what portion from DSI?

Paul. It's -- that's -- 14% is definitely a great result for us. It's a little bit ahead of where we thought we would be at this point. It's only 1 quarter. We still believe in the 10% to 13% result for the year. In terms of bifurcating it between DSI and all the heavy lifting, that's a challenging assessment to make. But there's no doubt, a decent part of that is from both of those factors. But it's a good strong solid results, but still expecting 10% to 13% for the year.

So I wanted to get some more color around the 8% organic growth number. If you could give us a little bit more information around the -- how sustainable is the demand in the marketplace? What are you seeing in terms of your backlog in your contracts right now? How long do you think that organic growth rate can continue?

It's Jeff. As I said in my script, we had 24% growth in Europe, 11% growth in China. We had 3% growth on our legacy products excluding electrophysiology. If we break it down by region, Europe, I think there was a soft -- softer comp in Q2 last year. So obviously the number is pretty high. I don't believe we'll continue to see mid-20s in terms of growth. But the activities, the programs that were put in place in the back half of last year have really come through for us. So I can -- we sit here confident today that Europe will continue to be a growth driver for the business over the next 2 quarters. China continues to outperform our expectations. We believe they'll continue to finish in the mid-teen range for the year. We like what we see, both with our legacy business and our DSI business in China moving forward. We've got a great team of sales and marketing people there. So back half of the year, we should see positive results. And then in the U.S., I mean, once again, outside of electrophysiology, the business performed really well. And the lumpiness in the electrophysiology business, these large system sales, it's just a matter of timing. And so in the back half of the year, we think we'll see both the PCMI business and the electrophysiology business with strong results. So we feel confident that back half of the year is going to be a banner year for Harvard Bioscience.

Okay. Great. That's helpful. And then on the gross margin side, traditionally, Q2 is a little bit softer for you in terms of gross margins to get a rebound in the back half of the year. Do you expect to repeat in that pattern?

Bruce, it's Rob. Like I mentioned in my prepared remarks, there is a level of seasonality from Q3 to Q4. So if you look back historically year after year, the third quarter is always the lowest quarter, the fourth quarter is the highest quarter. There'll be a small effect in gross margin because of that. I wouldn't expect it to be significant. And we still feel confident in that range that we provided guidance for the year. Clearly, the DSI acquisition and the divestiture of Denville has had a significant positive effect on gross margin that we're realizing, and we're excited about that.

It's Rob. We've been leveraging the cash flow generation of the business as well as some cash that was on the balance sheet and some of our ex U.S. cash. I think that that's probably a faster pace than what you'll see going forward. But it is a good result. We'll continue to work it down, but be more in line with the scheduled principal payments going forward.